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Nov 2008 H1 Economics Paper 1 Case Study Question 2 ai) The world price of oil sees an overall increase

from US$9.09 to US$54.52 per barrel between 1970 and 2005. In the first decade, the world price of oil shot up tremendously by 864%. In the next 2 decades, world price of oil drop for -59% and subsequently stabilized in the region of US$32. From 2000 to 2005, world price of oil again increased by 65.8% within a short span of 5 years.

aii) The rapid industrialization in China has contributed greatly to the increase in world demand for oil an a factor input for production and transportation. In response to the high global demand for oil and its rising value, there is an added incentive for oil producing countries to venture into oil exploration using more advanced technology. However, this may take a long time and coupled with OPECs manipulation of oil supplies to control prices, it is likely that any increase in supply of oil will be lesser then the increase in demand for oil. As seen from the diagram below, both demand and supply for oil increased as shown by a rightward shift both demand and supply curves from D1 to D2 and from S1 to S2 respectively. The resultant is an increase in its price level to P2 and output level to Q2.
S1 S2 Price

P2 P1 D1 Q1 Q2 D2 Quantity

Rapid industrialization in China has resulted in a problem of resource and energy shortages, which is a phenomenon seen in many other countries as well. The future supply of oil may be highly limited, thus pushing its prices even higher.

b) Brazil will benefit from the increase in world demand for this ethanol as an energy source. Brazil being the worlds largest and lowest cost producer of ethanol has a comparative advantage in producing this substitute for oil-based products. The growing demand for ethanol at 8% per year, indicate that Brazil will see an increase in demand for her ethanol exports. The increase in export earnings for Brazil brings about an increase in aggregate demand (AD), and via the multiplier process brings about a multiple increase in national income and therefore increasing actual growth and employment. However, this may lead to demand pull inflation in Brazil if their productive capacity do not increase to match up with the increase in their demand. However, Singapore who is heavily reliant on foreign imports for food sources, may suffer from an imported inflation as food prices soar. The rise in demand for ethanol and its grains as raw materials sees a competition in demand between food and fuel producers which drive up prices. Since food is a basic necessity with an inelastic

demand, an increase in food prices will bring about a less than proportionate fall in quantity demanded of imports, leading to an overall increase in import expenditure. A fall in net exports earnings (X-M) will bring about a fall in aggregate demand (AD) and thus slowdown growth and raises unemployment level. ci) Specialisation and free trade is beneficial to countries involved if each one specialises in the production of the good which she has the lowest opportunity cost in or a comparative advantage. Assuming suitable terms of trade, both countries experience a rise in consumption, indicating a higher standard of living and overall world production will increase. Signing of NAFTA allows for freer trade between countries through elimination or lowering of trade barriers. Lower import prices of raw materials due to lower tariffs will lower cost of production. This can help curb cost push inflation and also improve the price competitiveness of exports. An improvement in net export earnings brings about an increase in aggregate demand (AD) and a multiple increase in national income through the multiplier process. This will increase actual growth and employment. Lower import prices of consumable products can improve standard of living and a greater variety of foreign imports will increase consumers satisfaction. Signing of FTAs also allow countries to have more export destinations. A larger foreign market allows countries to produce more and enjoy possible economic of scale which would lower costs and further improve price competitiveness. The enlargement of the market from a domestic one to a world market encourages investment that in the long run facilitates economic growth and development for the country. FTAs promote investments between member countries where controls on investment were relaxed. This can help attract more FDIs, create more jobs and enable more technological transfer. As seen from extract 8, many factories in the USA and Canada relocated to Mexico to take advantage of its lower cost of production. This will create more job opportunities in Mexico thus bringing about an improvement in their national income. FTAs also grant more access, lower costs for firms to invest abroad and also aid in the expansion of local industry as they tap on the foreign larger market. The injection of competition in the domestic market due to foreign imports and firms reduces domestic producers' monopoly control thus forcing them to stay competitive to survive. Hence, domestic producers are forced to seek improvement in the quality of their products, to reorganise and better manage existing resources so as to produce goods more effectively. This could help the domestic producers to gear themselves up to compete globally which ultimately generate employment and growth for the country concerned.

cii) Tariffs are taxes imposed on imports. By imposing heavy tariffs on imports of ethanol from Brazil, USA is attempting to protect domestic industries by increasing home production at the expense of imports.

(domestic supply curve)

P1 P0


Post tariff world supply


World supply

(domestic dd curve



D1 D0


The figure above shows that when an import tax is imposed on ethanol, the domestic price for ethanol increased from OP0 to OP1. This raises domestic production from OS0 to OS1 at the expense of imported ethanol from Brazil, which is reduced from S0D0 to S1D1. The increase in home production generates producers' gains amounting to area A, which indicates the extra profits made by home producers. The government also gains revenue from the imposition of the tariff given by area C. However, consumers do lose in a big way as they are getting less of the product and have to pay a higher price. Consumers loss, in fact, more than offsets the gain to producers and the government. The resultant is a society welfare loss of area B+D.

d) Globalisation refers to any process that integrates all or most of the worlds economies, making countries increasingly dependent upon one another. The result of globalization is that there is freer movement of goods, services, firms, labour, technology and funds across international boundaries. Singapore, being a small and open economy that is import-dependent and exportoriented, is dependent on the global economy to prosper. One of the main benefits that Singapore gets from globalization is the increased availability of export markets. This will increase export revenue and hence aggregate demand (AD), and bring about a multiple increase in national income via the multiplier process, hence bringing about an increase in actual growth. In addition, with the increased market size, there is more scope for Singapore to engage in and reap greater economies of scale which will help firms enjoy lower costs of production and hence improve export competitiveness at the same time. The more than proportionate increase in quantity demanded for our countrys exports (due to elastic demand for exports) will cause an increase in production, and a consequent increase in employment in Singapore.

The increased competition from foreign firms will possibly result in price competition and also force firms to improve the quality of their products via research and development to prevent the loss in market share. The lower prices and better quality products as a result of competition will benefit consumers. Consumers can now also enjoy a greater variety of goods and services with the world markets becoming more open with globalization. Firms may even relocate or outsource stages of production to other countries to take advantage of the lower costs of production for certain production activities, for example, manufacturing activities are relocated to China, Indonesia and Vietnam, while the R&D activities are still in Singapore. Despite the many benefits of globalization to Singapore, globalisation is not without its costs. With increased competition as a result of increased globalization, firms which are unable to restructure fast enough would lose out, especially to countries like China which poses increased competition and a low-cost base. In addition, the out-sourcing of operations to lower-cost labour and resource countries would also lead to the loss of jobs. Workers who lose their jobs may be unable to acquire new skills quickly enough to find employment in other sun-rise industries, hence increasing structural unemployment. Increased globalization may result in widening income gap due to freer movement of labour across international boundaries. Singapore could import lower-cost unskilled foreign workers to replace relatively more expensive local workers, causing the local unskilled workers to suffer from stagnant or falling earnings. On the other hand, the increase in demand for skilled workers due to increased globalization will push up their wages. This will widen the income gap between the skilled and unskilled workers, worsening income inequality in Singapore.

Since economies are more closely integrated with one another as a result of increased globalization, they are also more vulnerable to the various risks from its trading partners and other economies, for example, the spreading of one countrys problem such as a recession, to another country more easily. Increased globalization brings about both benefits and costs. Singapore will benefit more from the increased globalization if the Singapore government is able to maximize the opportunities by restructuring the economy through the development of new niche areas that she has a new comparative advantage in. The Singapore government should also convert the threats of globalisation into opportunities or at least minimize the costs of globalization. For example, by providing funding and sending workers for retraining so as to equip them with the skills needed in the sunrise industries. To address the problem of widening income gap, the Singapore government can design policies to redistribute wealth such as providing cash grants to help the lower income groups.